What is the Nominal Interest Rate?

The nominal interest rate is the interest percentage stated in a contractual lending arrangement. This interest rate is not adjusted for the effects of inflation, so the return to the lender could be negative, if the inflation rate is higher than the nominal interest rate. Consequently, a lender must build inflationary expectations into the interest rate associated with a loan, or include a clause that adjusts the nominal interest rate for the effects of inflation.

Example of the Nominal Interest Rate

For example, if the inflation rate is 10% and the nominal interest rate on a loan is 8%, then the lender will experience a negative return of 2%. Conversely, if the inflation rate is only 2%, then the lender will experience a positive return of 6% on the loan.